What is Valuation?
Valuation is the process of determining what something is actually worth. It's the foundation of smart investing.
The Core Question
"What is this company worth, and am I paying a fair price?"
This is THE question every investor should ask before buying any stock.
The Used Car Dealer
You're buying a used car. The dealer says $25,000.
How do you know if that's fair?
You'd probably:
- Check what similar cars sell for (comparables)
- Consider the car's condition, mileage, features (fundamentals)
- Calculate if the price makes sense for what you're getting (valuation)
Stock valuation works the same way—just with different metrics.
Why Valuation Matters
Scenario 1: Ignoring Valuation
You buy a great company at any price. The stock is at $100, but it's only worth $50. Even if the company does well, you might lose money because you overpaid.
Scenario 2: Using Valuation
You buy the same great company, but wait until it's $40 (below its $50 value). Now you have a margin of safety AND upside potential.
The difference: Valuation discipline turns good companies into good investments.
The Two Approaches to Valuation
1. Absolute Valuation
Question: What is this company worth in dollars?
Methods:
- Discounted Cash Flow (DCF)
- Dividend Discount Model
- Asset-based valuation
Pros: Theoretically precise Cons: Requires many assumptions, complex
2. Relative Valuation
Question: Is this company cheap compared to similar companies?
Methods:
- P/E Ratio comparison
- P/B Ratio comparison
- P/S Ratio comparison
Pros: Simple, practical Cons: Depends on peers being fairly valued
Key Takeaways
- Valuation determines if a price is fair for what you're getting
- Absolute valuation estimates intrinsic worth
- Relative valuation compares to peers
- ShareValue.ai uses relative valuation for simplicity and practicality
ShareValue.ai's Approach
We use relative valuation because:
- It's practical — Works for any stock, any sector
- It's comparable — Easy to rank stocks against each other
- It's updated — Changes as prices and fundamentals change
- It accounts for sectors — Tech vs. banks have different norms
Our Valuation Score compares each stock to its sector peers on multiple metrics:
- P/E Ratio
- P/B Ratio
- P/S Ratio
- And more...
The Valuation Spectrum
| Valuation | What It Means | Typical Cause |
|---|---|---|
| Undervalued | Price < Worth | Market pessimism, overlooked, temporary problems |
| Fairly Valued | Price ≈ Worth | Market has priced it correctly |
| Overvalued | Price > Worth | Market optimism, hype, growth expectations |
Your goal: Find undervalued stocks (or at least fairly valued ones).
The Efficient Market Debate
Some believe markets are "efficient"—stocks are always fairly priced. Others believe markets make mistakes, creating opportunities.
ShareValue.ai takes the practical view: markets are mostly efficient, but mispricings happen. Our job is to find them.
Common Valuation Mistakes
Valuation Traps
- Confusing "low price" with "low valuation" (a $5 stock can be overvalued)
- Ignoring valuation because you "love the company"
- Using one metric in isolation (P/E alone isn't enough)
- Comparing across different sectors (tech vs. utilities)
Next up: Let's dive into the most famous valuation metric—the P/E Ratio.